Pigouvian Tax

10 Key excerpts on "Pigouvian Tax"

• 

  eBook - ePub

  Environmental and Natural Resources Economics

  Theory, Policy, and the Sustainable Society

  • Steven Hackett, Sahan T. M. Dissanayake(Authors)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  Whenever firms freely pollute or cause environmental harm in otherwise competitive markets, firms are being subsidized by society and consumers are sharing in this subsidy by way of a lower product price. This subsidy makes it particularly difficult for cleaner alternative technologies to succeed in the marketplace. If one firm were to adopt a more expensive clean technology, it would be at a price disadvantage in the marketplace relative to other firms. Unless consumers recognize and reward products made with the use of cleaner technologies, such firms will struggle and fail in the competitive marketplace. As we will see in the next section of this chapter, Pigouvian Taxes eliminate this subsidy and enhance market efficiency.

  Pigouvian Taxes: The Theory of Policy Interventions for Negative Externalities

  Economist A.C. Pigou (1920) suggested that the solution to the problem of negative externalities is to place a tax on each unit of output that is equal to marginal external cost. Accordingly, taxes on each unit of output (such as cabinets) equal to marginal external cost are called Pigouvian Taxes (sometimes spelled “Pigovian” taxes). Therefore, if we tax firms $3 per cabinet in our example, an amount equal to the marginal external cost from producing each cabinet, two things will happen. First, the social-cost supply curve will become operational in the market, as firms are now paying both marginal private cost and marginal external cost. As a result, fewer cabinets will be produced, and each cabinet will sell at a price that reflects the marginal social cost of production. Consequently, firms and consumers in the market internalize negative externalities, and society is reimbursed for bearing the external costs of production, resulting in efficient resource allocation.

  Pigouvian Taxes

  A tax (named after its original advocate, economist A.C. Pigou) placed on firms that is equal to the marginal external costs resulting from their pollution emissions. For example, if each unit of a good or service produced by a firm generates $20 in marginal external cost, then a Pigouvian Tax of $20 on each unit of the good produced would internalize the marginal external cost, thereby resolving the market inefficiency caused by the presence of the negative externality.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  How to Regulate

  A Guide for Policymakers

  • Thomas A. Lambert(Author)
  • 2017(Publication Date)
  • Cambridge University Press

    (Publisher)

  It is therefore necessary that an authority of wider reach should intervene.” 7 Specifically, Pigou concluded, “[i]t is . . . possible for the State, if it so chooses, to remove the divergence in any field by ‘extraordinary encourage- ments’ or ‘extraordinary restraints’ upon investments in that field. The most obvious forms which these encouragements and restraints may assume are, of course, those of bounties and taxes.” 8 In other words, the government should tax activities that create negative externalities and subsidize those that create positive externalities, thereby ensuring that the actors at issue bear the full cost and receive all the benefit of their conduct. If they do, they’ll act optimally, taking all actions that generate benefits in excess of cost and none that don’t. Thus was born the idea of “Pigouvian” (or sometimes “Pigovian” or “Pigonvian”) taxes and subsidies, the effects of which are illustrated in Figures 4.5 and 4.6. 7 A.C. Pigou, The Economics of Welfare (London: Macmillan and Co., 1920), 195. 8 Ibid. at 192. 36 Externalities Many governments, especially those in Europe, have utilized Pigouvian Taxes to address a number of environmental concerns. Norway, for example, imposed a tax on sulfur in mineral oil as far back as 1971, about the time the major command-and-control environmental statutes were enacted in the United States. Norway has since imposed taxes on non-refillable beverage containers, pesticides, lubricating oil, lead in petroleum, nitrogen and phos- phorous in fertilizers, and carbon dioxide from numerous sources. Germany has similarly imposed a number of so-called green taxes. Austria, Portugal, and the Netherlands charge progressive automobile registration fees that exact $ Output Individual MC Total MC Total MB 0 Q C Q X Tax = Difference between Individual and Total Marginal Cost of production. Tax raises Individual MC to align with Total MC. That causes producer to reduce output from Q X to Q C , eliminating welfare loss.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  International Trade, Welfare, and the Theory of General Equilibrium

  • Sugata Marjit, Saibal Kar(Authors)
  • 2018(Publication Date)
  • Cambridge University Press

    (Publisher)

  Hence, the socially optimal Pigouvian Tax rate in a small open economy is unambiguously positive. Herein, we have set aside the problems relating to measurement and implementation of the tax mechanism and other alternatives to deal with ‘pollution’ and concentrate on the Pigouvian Tax principle solely from the perspective of social welfare. 1 1 For issues relating to measurement and implementation problems of the Pigouvian Tax principle and alternative ways to deal with negative externalities, one may go through Baumol (1972), Boettke (2012), Vaughn (1980), Barthold (1994), Coase (1960), Carlton and Loury (1980), Kohn (1986), Fullerton (1997), Fullerton and Metcalf (1998), Bovenberg and Mooij (1994), Goulder, Parry, and Burtraw (1997), Sandmo (2008), etc. 202 International Trade, Welfare, and the Theory of General Equilibrium Two pertinent questions arise at this juncture, which are as follows: (i) is the optimal Pigouvian Tax in a small open economy strictly positive even in the presence of other distortion(s), for example, labor market distortion? and (ii) does the sign of the optimal tax anyhow depend on the magnitude of negative externalities that the production of the dirty good generates? This theoretical piece attempts to provide answers to the aforementioned questions in terms of a 2 × 2 full-employment small open-economy model with exogenous labor market imperfection. The import-competing sector (Sector 2) produces a manufacturing commodity that causes health hazards, thereby lowering the efficiency of the workers. In Sector 2, workers receive an exogenously given higher wage than their counterparts in Sector 1. 2 Thus, we have exogenous labor market imperfection in Sector 2. In such a scenario, there is a Pigouvian production tax on the production of good in Sector 2, which aims at tackling negative externalities generated by the production of Commodity 2.

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Public Sector Economics

  • Richard W Tresch(Author)
  • 2021(Publication Date)
  • Bloomsbury Academic

    (Publisher)

  These difficulties lead most economists to conclude that the Coase Theorem is inapplicable when externalities are widespread, which are precisely the kinds of externalities that governments become involved in. A Pigovian tax (or equivalent government policies – see below) is required to correct for externalities in these instances. E X T E R N A L I T I E S : P O L I C Y C O N S I D E R AT I O N S 125 B C A U 2 U 1 Figure 7.2 MEASUREMENT PROBLEMS IN DESIGNING PIGOVIAN TAXES The government faces two difficult measurement problems in trying to set the optimal Pigovian tax for any aggregate pollution externality. The first is that the Pigovian tax has to be equal to the aggregate marginal damages at the optimum . The second is that there are severe gaps in our scientific knowledge about the benefits of reducing pollution. ITERATING TO THE OPTIMUM Suppose the government can measure the marginal damages of pollution accurately. Even so, when it first attempts to measure the marginal benefits to establish the Pigovian tax, it will be measuring them at the wrong level of pollution. Refer to Figure 7.3 , which builds on Figures 6.4 and 7.1(a) for our pollution-proportional-to-output case. The Pigovian tax is t opt , equal to the distance gh between S soc and S priv at Q opt , the aggregate marginal damages at the optimum. But the market is at the competitive equilib-rium (Q c , P c ) before the government places a tax on the paper firms. Therefore, when the government first measures the aggregate marginal damages, it will measure them as ab, the distance between S soc and S priv at Q c . If Q c is far from Q opt , ab could far overstate the aggre-gate marginal damages at Q opt , which is what the government would like to know. P U B L I C S E C T O R E C O N O M I C S 126 Figure 7.3 The government may be able to iterate close to the optimum with a series of taxes, however, as illustrated in Figure 7.3 .

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Environmental Economics for Non-Economists

  • John Asafu Adjaye(Author)
  • 2000(Publication Date)
  • WSPC

    (Publisher)

  To give an example of a Pigovian tax, suppose the demand curve for pollution abatement is D and the supply of pollution abatement is S (Figure 4.9). The government would try to set the charge at /?*, where demand equals supply. However, this approach faces a similar constraint as standards in the sense that both the demand and supply curves are not known with certainty. In practice the charge is likely to be set at a point p < p* at which the level of pollution abatement will be less than optimum. Pearce and Turner argue that attempting to calculate an 'optimal' tax is unrealistic. What is needed is the kind of information that would tell us whether we are very wide of the mark in taking a particular pollutant or whether we are in the right 'ballpark' (Pearce and Turner, 1990:97). Economists prefer charges to other pollution abatement alternatives because charges offer firms an economic incentive to reduce pollution. Different firms have different pollution abatement costs. By imposing a charge per unit of pollution, emission charges induce firms to lower their emissions to the point where the marginal cost of abatement equals the charge. Unlike standards, which are applied uniformly to all polluters, charges enable firms to adopt a cost-effective solution to pollution 88 Environmental Economics abatement. Compared to standards, there is a stronger incentive for firms to adopt new technology in order to lower the charges they have to pay. Figure 4.9 An example of a Pigovian tax Price ($) In spite of the above advantages, charges and taxes do have some disadvantages. The problem associated with setting an optimum tax due to uncertainty about the demand and supply curves has already been discussed above. In addition, the costs of monitoring emissions could be high. Furthermore, there are a number of equity issues arising from such a tax. First, firms could pass on a portion of the tax to consumers in the form of higher product prices.

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Incentives and Environmental Policies

  From Theory to Empirical Novelties

  • Benjamin Ouvrard, Anne Stenger, Benjamin Ouvrard, Anne Stenger(Authors)
  • 2019(Publication Date)
  • Wiley-ISTE

    (Publisher)

  The effectiveness of these new incentivizing policies was supported in the early 1970s by least-cost theorems, and would cement the split between regulatory (command and control) instruments and incitative (market-based) ones (see section 1.5.2). 1.1. From Pigou to the origins of the concept of externality A pupil of Alfred Marshall at Cambridge University, whose chair he took over in 1908, Arthur Pigou focused in his 1920 book on the welfare economics; more specifically, on the reallocation of resources to increase national revenue, which correlated in his opinion with social welfare. In the book, he examines the misallocation of these resources, identified as divergences between the collective cost and the private cost of an output, and links these divergences, these sources of inefficiency, to principles of government intervention. The divergences can have varying origins, including increasing returns in an industry (here Pigou draws on Marshall’s concept of external economies 3) and the presence of external effects connected to an industrial activity. At this point, Pigou develops the first outline of what would become the concept of externality: “A person A, while he is in the process of providing a certain service, for payment, to another person B, inadvertently affects other people, for better or worse, who do not provide similar services, in such a way that payment cannot be demanded from those benefiting from it, and nor can compensation be provided to those suffering from it”. (Pigou, 1920, p. 183) The examples provided by Pigou concern deforestation, investment in scientific research, the construction of factories and air pollution. The government must intervene and, through taxes or subsidies (extraordinary encouragements or extraordinary restraints, (Pigou, 1920, p

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Handbook of Environmental Economics

  Environmental Degradation and Institutional Responses

  • Karl-Goran Maler, Jeffrey R. Vincent(Authors)
  • 2003(Publication Date)
  • North Holland

    (Publisher)

  General-equilibrium analysis has relatively recently been applied to examine whether environmental policies that appear to be optimal in a partial-equilibrium context might in fact need to be adjusted in response to the existence of other distortions. The chapter by Lars Bergman in this Handbook describes methods for conducting applied general-equilibrium analysis of environmental policies, and the chapter by Raymond Kopp and William Pizer compares partial-and general-equilibrium estimates of the impacts of environmental regulations on production and abatement costs. Here, we highlight theoretical results related to the interactions between pollution control instruments, especially market-based instruments, and taxes on goods other than pollution or polluting inputs. The chapter by Markandya provides a more comprehensive review of the literature on interactions between environmental and nonenvironmental policies.

  In a general-equilibrium setting, the level of the optimal pollution tax depends on the levels of other taxes. As a result, the optimal general-equilibrium pollution tax is likely to differ from a partial-equilibrium Pigouvian Tax that is used only to correct the pollution externality.12 This is because a tax that is levied to reduce pollution has the added effect of raising revenue. If that revenue is used to reduce or replace other taxes, then there is the potential for a “double dividend”: less pollution and less deadweight loss from other taxes.

  The taxing of pollution has three effects on welfare. First, it decreases the production of the dirty good that creates the externality. Although an effluent tax can be viewed as just one of many commodity taxes, unlike most taxes it increases efficiency through its allocational effects. Second, in what is called the “recycling effect”, it raises revenue that can be used to lower other, more distortionary taxes. Third, it is itself a distorting tax, through its impacts on other markets.

  Bovenberg and de Mooij (1994) carry out an optimal tax exercise in a simple analytical model that includes a clean good and a dirty good, a tax on income (labor), and a tax on the dirty good. They conclude that the optimal tax on the dirty good is less than the rate that would be used to correct the externality. Taxing income causes agents to work less and consume more leisure than they would in a first-best world. As a result, there is a marginal cost to raising public funds, which is likely to be greater than one. The optimal tax on the dirty good is shown to be the Pigouvian Tax divided by the marginal cost of raising public funds, so it is less than the Pigouvian Tax.

  Fullerton (1997) reinterprets this conclusion. Because income in Bovenberg and de Mooij’s model is all from labor and is all spent on the clean and dirty good, the same budget constraint results whether labor is taxed at rate t or both goods are taxed at the rate (1 – t )−1 . That is, the tax on income is equivalent to a uniform tax on both goods. Viewed with that normalization, the total tax on the dirty good – the sum of the income tax expressed as the equivalent uniform tax on both goods and the additional tax on just the dirty good – is greater than the Pigouvian Tax.13

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Microeconomics in Context

  • Neva Goodwin, Jonathan M. Harris, Julie A. Nelson, Pratistha Joshi Rajkarnikar, Brian Roach, Mariano Torras(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  Because the externality represents a cost, to determine the net social welfare we need to subtract the environmental damages from the market benefits. Thus, the net social welfare of the unregulated market is:

  Net Benefits =

  ( A + B + E + H ) +

  ( C + D + F + G + I )

  −

  ( E + F + G + H + I + K )

  Canceling out the positive and negative terms, we are left with:

  Net Benefits = A + B + C + D − K

  Now, we impose a Pigovian tax that fully internalizes the externality. This is shown in Figure 12.8 , which is based on Figure 12.2 . We again need to determine the areas that represent consumer surplus, producer surplus, and the externality damage. But we also need to consider that tax revenues represent a benefit to society, as we did in Chapter 11 .

  Figure 12.8 Welfare Analysis of a Negative Externality, with a Pigovian Tax

  With the Pigovian tax, the new equilibrium is ETax , with a higher price of PTax and a lower quantity of QTax . At the higher price, consumer surplus is:

  CS = A

  As seen in Chapter 11 , we can figure out producer surplus by first realizing that total revenues equal price times quantity, or (PTax × QTax ). In Figure 12.8 , total revenues are:

  Total Producer Revenues = B + C + D + E + F + G + J

  Producers have two costs: the cost of production and the tax. The cost of production is the area under their marginal cost curve, which is area J. The tax per unit is equal to the difference between PTax and P0 , which must be paid for every unit produced. Total taxes paid equal the shaded area in Figure 12.8 ,* or:

  Taxes = E + F + G

  When we subtract production costs and the tax paid from total revenues, we are left with producer surplus:

  Producer surplus =

  ( B + C + D + E + F + G + J ) − J −

  ( E + F + G )

  =

  B + C + D

  Note that both consumer and producer surplus have decreased as a result of the Pigovian tax. If both consumer and producer surplus have gone down, how can it be that the tax increases social welfare? First, we need to account for the reduced pollution. With quantity reduced to QTax , the total externality damage is now the shaded area in Figure 12.8

  Sign up to read

  Learn more about book
• 

  eBook - ePub

  Distributional Effects of Environmental and Energy Policy

  • Don Fullerton(Author)
  • 2017(Publication Date)
  • Taylor & Francis

    (Publisher)

  Table 1 . Buyers pay more for the product, so they lose consumer surplus area 2 + 3 + 4. Firms still earn zero profits. The government raises revenue area 2 + 3, and the net loss, so far, is area 4. Victims gain from the reduction in environmental damages, area 4 + 5 + 6, so the net gain to society is area 5 + 6, just as stated above. This net gain is the “efficiency effect” from correcting the externality. It reflects the fact that the costs of that extra pollution exceeded the benefits of it (by area 5 + 6).

  The first main result from this diagram and table is now clear: Although some may promote this reform on the basis of the net gain to society, not everybody shares in the gain. Consumers lose, while environmentalists gain, and these different groups are unlikely to agree on the merits of the reform. Displaced workers may also oppose it, making the net gain hard to obtain.6

  Interestingly, the United States does not use any good examples of a Pigouvian Tax on pollution. The Internal Revenue Service (IRS) Statistics of Income identifies four “environmental” taxes, on (i) petroleum, for the Oil Spill Liability Trust Fund and Superfund; (ii) chemical feedstocks, for Superfund; (iii) ozone-depleting chemicals, for the general fund; and (iv) motor fuels, for the Leaky Underground Storage Tank fund. These are called environmental taxes not because they discourage pollution, but because their revenues are used for environmental purposes such as the Superfund cleanup of contaminated sites. Taxes apply to all petroleum and chemical purchases, not to chemical or petroleum wastes, and thus do not affect the proportion of those inputs that become waste by-products. They are not designed to discourage pollution but to collect from those deemed responsible for pollution.7

  Subsidy for Abatement

  The other Pigouvian solution is for the government to pay the firm to cut back on polluting production. Suppose the policy states that each firm will be paid tz (the same amount as before, p′ − p°) for every unit of pollution reduced from the initial point Z°. Then for each unit of pollution, the firm bears a “cost” equal to the subsidy it must give up by not reducing that unit of pollution. The full cost of pollution is P′, the PMC (P°) plus the subsidy foregone. The firm pollutes as long as the marginal benefits exceed this cost P′ that is, to Z

  Sign up to read

  Learn more about book
• 

  eBook - PDF

  Public Finance

  A Normative Theory

  • Richard W. Tresch(Author)
  • 2002(Publication Date)
  • Academic Press

    (Publisher)

  7.6, on the nonconvex region of the frontier. Opportunity costs are incorrectly measured by the slope of I 0 at D. A Pigovian tax reduces production of X 1 and moves society to point T, where indi V erence curve I 1 is tangent to the frontier. Although T is an improvement over D, it is only a local optimum. 230 CONCLUDING COMMENTS: THE PROBLEM OF NONCONVEX PRODUCTION POSSIBILITIES The global optimum is at point G, the tangency of I 3 with the frontier, and a Pigovian tax cannot possibly achieve G starting from D. A similar demon-stration applies to the case of external economies. A common example is a laundry X 2 ) sitting downwind from a factory X 1 ). A Pigovian tax on the smoke emitted by the factory may bene W t the laundry by reducing the smoke pollution. The least-cost solution, however, may simply be to have the laundry move upwind from the factory and thereby avoid all or almost all) of the smoke pollution. The laundry±factory example is a speci W c instance of a more general question: How must optimal policies be adjusted if the victims of an external diseconomy such as pollution can partially or completely defend themselves from the external e V ects? The example illustrates one wrinkle, that defensive strategies can themselves give rise to nonconvexities. We will consider the question of defensive expenditures in more detail in Chapter 8 as part of the discussion of U.S. antipollution policy. Waste treatment, a defensive strat-egy, is an important part of the United States' W ght against pollution, and it is justi W ed on the basis of decreasing cost nonconvex) production. REFERENCES Baumol, W. J. and Oates, W., The Theory of Environmental Policy , Prentice-Hall, Englewood Cli V s, N.J., 1975. Buchanan, J. and Kafolgis, M., ``A Note on Public Goods Supply,'' American Economic Review , June 1963. Diamond, P. and Mirrlees, J., ``Aggregate Production with Consumer Externalities,'' Quarterly Journal of Economics , February 1973.

  Sign up to read

  Learn more about book